Why shouldn't I take an early distribution from my retirement funds?

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Question:

I heard you can take some of your money out of your IRA, 401(k), or 403(b) earlier than age 59 1/2 without penalty. Can you give me some information on this?

Answer:

You heard right. But there are drawbacks involved in getting your hands on the cash early.

Getting money out of your IRA before you turn age 59 1/2 is a lot easier than getting money out of your employer's plan. With an IRA, there is nothing to prevent you from taking the money out whenever you want. But when you do take the money, you pay income tax. And if you happen to be younger than 59 1/2, you will also pay a 10% early distribution penalty, unless you qualify for one of the exceptions to the penalty -- for example, you die or become disabled.

Getting money out of your 401(k) plan before you reach age 59 1/2 is trickier. Most company plans will not allow you to take money out while you are still on the job.

The two big exceptions are hardship distributions and loans. To take a hardship distribution, you must satisfy the plan's definition of hardship. If you qualify, you will still have to pay income tax and an early distribution penalty on any money that comes out of the plan. The best alternative is a loan, if the plan allows one. But even if you are permitted to borrow from the plan, you must pay the money back with interest within five years, usually in installments.

The 403(b) plan rules are similar. And your best option with a 403(b) plan is also a loan.

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